FSA acts on asset segregation – hope yet for investors?

Yesterday’s news that JP Morgan has been hit with the largest fine ever handed down by the FSA might not appear to have any direct connection to shareholder stewardship, after all it wasn’t their securities servicing division found to be at fault. But bear with us.

Banks have strict rules which require client assets to be properly segregated. As today’s Guardian says: “Regulators, rightly, are appalled by its failure to keep segregated accounts. It undermines faith in banks in general; it shows inept internal controls; and it can make financial disasters more intense if clients’ access to their cash is restricted” .  But it isn’t just cash that’s a client asset at risk, it’s their investment assets too.

In the days before the rise of the mega-custodian bank, UK shareholders owned shares in their own name and were easily identifiable as such on company share registers. It’s true that they might have used a nominee company to do that, but the accounts were individually designated so that the assets, from a legal perspective, were properly segregated and easily identifiable so that they could not be confused with anyone elses.

As a product manager at a British-owned custodian bank once said at an industry group meeting (admittedly about 10 years go): “In the unlikely event of a bank going bust, designated accounts are the proper protection for shareholders”.  His comment was met with gasps of astonishment – “but banks don’t go bust” was the concensus from the US banks around the table. How times have changed.

Why do designated accounts matter today? When equity assets are pooled in a bank’s omnibus account client access to their assets is restricted and the voting chain becomes unecessarily complex. Where once a shareholder would receive annual reports directly from a company and be able to communicte directly with management, ownership is now obfuscated through layers of unecessary banking beaurocracy. In 2007 Manifest produced a white paper which outlines some of the issues. For more details Click Here >>

The Financial Reporting Council and the UK Government is currently raising expectations of shareholders as stewards.  Investors need time to make informed voting decisions, together with the comfort and assurance of transparent audit trails and accurate transaction processing, even more so when UK directors are to be asked to be re-elected every year. But for as long as custodians insist on pooling equity assets audit trails will be compromised, voting deadlines will be uncessarily padded, stock lending will be murky, corporate actions missed. Furthermore, investors will not have the freedom to exercise their rights in a way which best suits them rather than having to battle with a service provider which the client didn’t chose and is not directly accountable to them – a point which will be far from lost on clients of JP Morgan Securities Services who had their voting platform changed for them by their custodian only last year without adequate consultation in the eyes of  many.

For too long banks have given the appearance of running their businesses for the convenience of their own P&L and not their customers’needs. Requests for account designation have been met with blanket refusals and the concept of unbundling services met with fierce resistance. Cross-border ownership and voting can work effectively, but Europe must move to a designated accounts framework for all customer assets at the earliest opportunity at both the master and sub-custodian level. This will ensure that the increased focus on ownership engagement is not let down by the weakest link in the chain of intermediaries.

Open markets based on open operating standards and freedom of choice are taken for granted elsewhere in daily business. Why should corporate governance and proxy voting be the exception to that rule?

As the Guardian concludes: “once the structure of financial regulation is decided, the issue (audit and compliance) should be addressed. Segregation of accounts is basic stuff.”  We couldn’t agree more.

Size has never been a measure of competence as the banks have yet again demonstrated.





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